Agency costs -- what is this?
- Thread starter sridhar
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Hi sridhar,
Yes, nice observation, I agree "agency" is thematic. Its traditional, broad meaning refers to any of several...
PRINCIPAL - AGENT relationships
As in,
Investor (Principal) - Asset manager (Agent; acting on behalf of)
Pension fund beneficiaries (Principal) - Trustees (Agent)
And often but not always entails a legal *fiduciary* responsibility, of the Agent to act in the interests of the Principal.
For our purposes, it manifests in subprime securitization readings where agency costs are EXACERBATED by information asymmetries; e.g., maybe you the principal give money to your asset manger (the agent)...he knows more than you and he does the job full time...this makes it harder for you me to monitor him/her. Agency costs are any costs incurred for you to mitigate/remedy the agency problem, or the costs of a failure/loss due to his acting in his own best interest instead of yours.
And in Stulz as an Agency COST: Shareholders are the principals who own the company and they entrust the company to their agents, Company Management (says Stulz, but he is technically incorrect, the Board of Directors are the agents of shareholders. The Board monitors on behalf of SH)
So, the classic issue in capitalism is, how do dispersed owners solve their "agency problem" (the fact they don't really monitor the company and managers will act in their own best interests). At few classic solutions: fiduciary laws; ethical standards (e.g., a CFA has "agency" responsibilities beyond the law); compensation plans (do options "align"); high leverage (EVA theory; discipline of debt); and private equity/activist investors (big shareholder exerting influence). And Stulz says, agency costs here are any incremental increase in the cost of capital that owes directly to the concern that the current managers are not acting in shareholder's best interests.
One last illustration (since it is really interesting, to me!): setting aside any opinions one may have of Carl Icahn (who is blogging, fantastic), if he is correct and his activism increases shareholder value than you could call the value that he unlocks the agency costs. According to his worldview, certain companies trade at a discount due to less-than-great Boards.
David
Yes, nice observation, I agree "agency" is thematic. Its traditional, broad meaning refers to any of several...
PRINCIPAL - AGENT relationships
As in,
Investor (Principal) - Asset manager (Agent; acting on behalf of)
Pension fund beneficiaries (Principal) - Trustees (Agent)
And often but not always entails a legal *fiduciary* responsibility, of the Agent to act in the interests of the Principal.
For our purposes, it manifests in subprime securitization readings where agency costs are EXACERBATED by information asymmetries; e.g., maybe you the principal give money to your asset manger (the agent)...he knows more than you and he does the job full time...this makes it harder for you me to monitor him/her. Agency costs are any costs incurred for you to mitigate/remedy the agency problem, or the costs of a failure/loss due to his acting in his own best interest instead of yours.
And in Stulz as an Agency COST: Shareholders are the principals who own the company and they entrust the company to their agents, Company Management (says Stulz, but he is technically incorrect, the Board of Directors are the agents of shareholders. The Board monitors on behalf of SH)
So, the classic issue in capitalism is, how do dispersed owners solve their "agency problem" (the fact they don't really monitor the company and managers will act in their own best interests). At few classic solutions: fiduciary laws; ethical standards (e.g., a CFA has "agency" responsibilities beyond the law); compensation plans (do options "align"); high leverage (EVA theory; discipline of debt); and private equity/activist investors (big shareholder exerting influence). And Stulz says, agency costs here are any incremental increase in the cost of capital that owes directly to the concern that the current managers are not acting in shareholder's best interests.
One last illustration (since it is really interesting, to me!): setting aside any opinions one may have of Carl Icahn (who is blogging, fantastic), if he is correct and his activism increases shareholder value than you could call the value that he unlocks the agency costs. According to his worldview, certain companies trade at a discount due to less-than-great Boards.
David
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